Fiscal Procyclicality Research Articles

Commodity prices and fiscal policy design: Procyclical despite a rule

SummaryRecent studies offer evidence of reduced fiscal procyclicality to commodity price changes in resource‐rich countries—a feature commonly attributed to the adoption of fiscal policy rules. We revisit this issue and find that, by controlling for global activity shocks while allowing for time‐varying changes in both fiscal policy and the volatility of shocks, this finding does not hold. To show this we develop a time‐varying dynamic factor model, allowing for a multiple of shocks, stochastic volatility and time‐varying parameters, and estimate it on data for Norway, whose handling of resource wealth is often cited as exemplary.

Fiscal policy pro-cyclicality in Sub-Saharan African countries: The role of export concentration

Sub-Saharan Africa's exports remain dominated by primary commodities, and the need to diversify their production and export base appears as a matter of urgency. This paper investigates the impact of exports concentration on fiscal pro-cyclicality in sub-Saharan Africa. The concentration of exports limits the sources of revenues for governments and restrains the fiscal room for maneuver. Using a sample of 40 countries over the period 1995–2015, we find that export concentration increases the degree of fiscal policy pro-cyclicality, and this result is driven by the behavior of public investment. Our findings highlight the importance of diversifying exports in order to widen the range of revenue sources for governments and pave the way of countercyclical public investment capable of generating sustainable growth.

The Effects of Regulatory Quality on the Pro-Cyclicality of Fiscal Policy in Countries in the Central African Economic and Monetary Community (CA EMC)

This article aims to analyze the effects of the regulatory quality on fiscal pro-cyclicality in CAEMC member countries based on the annual panel data for the years 1996 to 2016. To achieve that, we used, on the one hand, the fiscal policy reaction function (Taylor, 2000) as well as institutional quality, and on the other hand, the system-generalized method of moments (system GMM) to empirically understand the effects of the regulatory quality on fiscal pro-cyclicality in CAEMC member countries. Our findings show that the current state of regulatory quality in CAEMC countries promotes the pro-cyclicality of the fiscal policy in this sub-region. In addition, these findings show that the effect of the current state of regulatory quality on fiscal pro-cyclicality is more significant when the regulatory quality is linked to the economic cycle. It is therefore necessary to bring about profound institutional reform in the CAEMC countries in order to redirect the fiscal budget towards counter-cyclicality.

On Graduation from Fiscal Procyclicality: The case of Bolivia

Since Frankel et al. (2013), many authors have sought evidence of the so-called graduation from fiscal procyclicality; this concept refers to the direction change experienced by a number of developing countries regarding the implementation of destabilizing procyclical policies in the past. While the cyclicality of fiscal policy in Bolivia has been evaluated by multiple authors, we believe that our contribution is relevant because it models the response of fiscal policy in a much more intuitive way, that is also less prone to some specification problems frequently cited in the literature

Fiscal Politics in the Euro Area

This paper provides evidence of fiscal procyclicality, excessive deficits, distorted budget composition and poor compliance with fiscal rules in the euro area. Our analysis relies on real-time data for 19 countries participating in the euro area over 1999–2015. We look for, but do not find, conclusive evidence of bias in procedures in relation to country size. The paper also briefly reviews the literature on political economy factors and policy biases, and offers some reflections on the euro area architecture.

Fiscal Politics in the Euro Area

This paper provides evidence of fiscal procyclicality, excessive deficits, distorted budget composition and poor compliance with fiscal rules in the euro area. Our analysis relies on real-time data for 19 countries participating in the euro area over 1999–2015. We look for, but do not find, conclusive evidence of bias in procedures in relation to country size. The paper also briefly reviews the literature on political economy factors and policy biases, and offers some reflections on the euro area architecture.

Fiscal Policy in Oil‐exporting Countries: The Roles of Oil Funds and Institutional Quality

AbstractOil‐exporting countries face challenges in the conduct of fiscal policy owing to volatile oil revenues, especially in countries with weak institutions. Many oil exporters have established oil funds to delink government expenditure from oil revenues; however, their effectiveness remains unresolved. This paper examines the roles of oil funds and institutional quality in reducing fiscal procyclicality and macroeconomic volatility in 42 oil‐exporting countries from 1960 to 2014 using panel vector autoregression techniques. The results show that oil funds are effective in reducing fiscal procyclicality in countries with high institutional quality. There is also a reduction in the procyclical bias in those with low institutional quality but the statistical evidence is weak. Nevertheless, oil funds are associated with reduced volatility of government consumption and the real exchange rate in countries with low institutional quality. These findings give credence to the macroeconomic stabilization role of oil funds but also reinforce the importance of good institutions.

Fiscal procyclicality and output forecast errors

Government spending in the developing world has historically been procyclical. Traditional explanations for this have mostly revolved around the explicit or implicit notion that fiscal procyclicality is the deliberate result of political economy distortions and weak institutions. Because of revisions in output growth forecasts around the world since the global financial crisis, two recent explanations in the literature have gained increasing support: (i) over-optimism in output forecasts as a cause of procyclicality, and (ii) real-time data, as opposed to ex-post data, as an explanation for policymakers' intended responses to output fluctuations, which in practice tend to deliver less procyclical “intentions” than reliance on ex-post data. This study revisits the implications of output forecast errors on fiscal procyclicality in light of these two recent strands in the literature. For this study, a simple conceptual framework was developed and empirical evidence presented using output forecasts for 101 countries. The results showed that: (i) over-optimism is neither necessary nor sufficient to explain fiscal procyclicality, and (ii) there is no reason to accept the interpretation that forecast errors have “unfortunate” systematic effects on fiscal procyclicality. Traditional political economy arguments help explain how governments handle unanticipated output fluctuations.

Limiting Fiscal Procyclicality: Evidence from Resource-Rich Countries

We provide evidence that fiscal policy in resource-rich countries is strongly procyclical. The empirical analysis reveals that on average real government consumption in these countries tends to significantly rise (fall) in good (bad) times. To control for endogeneity we use an instrumental variable for GDP growth that arises naturally, namely the growth in commodity prices of the main natural resource export. We also find that fiscal policy procyclicality is lower in more democratic regimes, and that operating a sovereign wealth fund is more successful in limiting fiscal policy procyclicality than introducing fiscal rules.

Was this time different?: Fiscal policy in commodity republics

We revisit the issue of fiscal procyclicality in commodity-rich nations–commodity republics in the nomenclature of this paper. Since commodity prices are plausibly a main driver of fiscal policy outcomes in these countries, we focus on the behavior of fiscal variables across the commodity cycle, in contrast to behavior across the output cycle, which has been the main focus of earlier research on fiscal procyclicality. We present evidence of reduced fiscal policy procyclicality in a number of countries. Our empirical results suggest that improvements in institutional quality have led to a more countercyclical fiscal policy stance in a number of countries. The presence of fiscal rules also seems to have made a difference: countries that use them displayed a larger shift toward fiscal counter-cyclicality between the two episodes.

A forensic analysis of global imbalances

We examine whether the behavior of current account balances changed in the years preceding the global crisis of 2008-09, and assess the prospects for global imbalances in the post-crisis period. Changes in the budget balance are an important factor affecting current account balances for deficit countries such as the U.S. and the U.K. The effect of the saving glut variables on current account balances has been relatively stable for emerging market countries, suggesting that those factors cannot explain the bulk of their recent current account movements. We also find the 2006-08 period to constitute a structural break for emerging market countries, and to a lesser extent, for industrialized countries. We attribute the anomalous behavior of pre-crisis current account balances to stock market performance and real housing appreciation; fiscal procyclicality and the stance of monetary policy do not matter as much. Household leverage also appears to explain some of the standard model's prediction errors. Looking forward, U.S., fiscal consolidation alone cannot induce significant deficit reduction. For China, financial development might help shrink its current account surplus, but only when it is coupled with financial liberalization. These findings suggest that unless countries implement substantially more policy change, global imbalances are unlikely to disappear.

On graduation from fiscal procyclicality

In the past, industrial countries have tended to pursue countercyclical or, at worst, acyclical fiscal policy. In sharp contrast, emerging and developing countries have followed procyclical fiscal policy, thus exacerbating the underlying business cycle. We show that, over the last decade, about a third of the developing world has been able to escape the procyclicality trap and actually become countercyclical. We then focus on the role played by the quality of institutions, which appears to be a key determinant of a country’s ability to graduate. We show that, even after controlling for the endogeneity of institutions and other determinants of fiscal procyclicality, there is a causal link running from stronger institutions to less procyclical or more countercyclical fiscal policy.

A Forensic Analysis of Global Imbalances

We re-examine the determinants of current account balances applying updated data to the framework based on Chinn and Ito (2007). The main purpose of this study is to examine whether the determinants of global current account balances changed during the period preceding the global crisis of 2008-09 while inquiring into the prospects for the global imbalances in the post-crisis period. Based on our estimates, changes in the budget balance appear to be an important factor affecting current account balances for advanced current account deficit countries such as the United States and the United Kingdom. The effect of the “saving glut variables” on current account balances has been relatively stable for emerging market countries, suggesting the prominence of those factors is not a particularly recent phenomenon. We also find the 2006-08 period to be the structural break for emerging market countries, and to a lesser extent, for industrialized countries. When we investigate what can explain the purportedly anomalous behavior in the current account balances during the 2006-08 period, we find that stock market performance and real housing appreciation explain the unusual current account balances in the pre-crisis period; fiscal procyclicality and monetary policy stance do not seem to matter as much. However, we also identify components of current account balances that can be only explained by country-specific factors. Extrapolating to the future, we find that for the U.S., fiscal consolidation alone cannot induce significant current account deficit reduction. For China, financial development may help shrink its current account surplus, but only when it is coupled with financial liberalization. These findings suggest that unless countries implement substantial policy changes, the global imbalances are unlikely to disappear.

A Tale of Cyclicality, Aid Flows and Debt: Government Spending in Sub-Saharan Africa

This paper documents cyclical patterns of government expenditures in Sub-Saharan Africa since 1970 and explains variation between countries and over time. Controlling for endogeneity and applying dynamic generalised method of moment (GMM) techniques, it finds that government expenditures are slightly more procyclical in Sub-Saharan Africa than in other developing countries and some evidence that procyclicality in Africa has declined in recent years after a period of high procyclicality during the 1980s and 1990s. We find suggestive evidence that greater fiscal space, proxied by lower external debt, and better access to concessional financing, proxied by larger aid flows, contributed to diminishing procyclicality in the region. We do not find, however, any evidence that political institutions affect fiscal procyclicality in Sub-Saharan Africa.

Rent-seeking distortions and fiscal procyclicality

Recent research has demonstrated that while government expenditures are countercyclical in most industrialized countries, they tend to be procyclical in developing countries. We develop a dynamic political-economy model to explain this phenomenon. In the model, public expenditures provide insurance to uninsured households, and optimal fiscal policy is countercyclical. The introduction of a political friction, in which successive governments disagree on the desired distribution of public spending, can lead to procyclical fiscal policies. Numerical simulations of the model allow us to compare quantitatively the relative role of common explanations for fiscal procyclicality. We conclude that political distortions in the fiscal process can explain fiscal procyclicality better than other common explanations, such as borrowing constraints and macroeconomic volatility.

Why Do More Polarized Countries Run More Procyclical Fiscal Policy?

We study the cyclical behavior of fiscal policy to explain why some countries exhibit procyclical fiscal policy stances—being expansionary in good times and contractionary in bad times. We develop a model that links the polarization of preferences over fiscal spending to the procyclicality bias. We then present evidence that social polarization as measured by income inequality and educational inequality is consistently and positively associated with fiscal procyclicality, even after controlling for other determinants from existing theories. We also find a strong negative impact of fiscal procyclicality on economic growth.

Fiscal Policy and Business Cycles in an Oil-Producing Economy: The Case of Venezuela

This paper analyzes the fiscal policy in Venezuela during 1991-2003, by using a number of statistical approaches to analyze trends and cycles of economic output and fiscal outcomes. The business cycle features a strong dominance of short-term cyclical components - each cycle having an average duration of about two to three years. However, the cyclical volatility of non-oil sector GDP is more than two times as large as the volatility of oil sector GDP. On the fiscal side, while oil revenues are independent of the business cycle, all the other main fiscal variables exhibit strong procyclicality. In particular, fiscal procyclicality is higher during good times than bad times, which could be related to the existence of voracity effects. The discretionary component of fiscal policy is as volatile as the component induced by the business cycle.

Fiscal Policy and Business Cycles in an Oil-Producing Economy: The Case of Venezuela

This paper analyzes the fiscal policy in Venezuela during 1991-2003, by using a number of statistical approaches to analyze trends and cycles of economic output and fiscal outcomes. The business cycle features a strong dominance of short-term cyclical components-each cycle having an average duration of about two to three years. However, the cyclical volatility of non-oil sector GDP is more than two times as large as the volatility of oil sector GDP. On the fiscal side, while oil revenues are independent of the business cycle, all the other main fiscal variables exhibit strong procyclicality. In particular, fiscal procyclicality is higher during good times than bad times, which could be related to the existence of voracity effects. The discretionary component of fiscal policy is as volatile as the component induced by the business cycle.